Description
EME's $3,854mm of senior unsecured notes (multiple issues) are trading at 75 cents on the dollar. After considering admin & priority claims and GUC claims, your claim entitles you to 55 points of non-risk recovery -- leaving you paying 20 points for the interesting at-risk stub. You need to over-size your position to get the right portfolio exposure to the at-risk stub; to make the at-risk stub a ~5% position, you need to make EME notes an ~18.8% position. That may look scary on a portfolio summary sheet, but the the non-risk portion of the claim is comprised of portfolio cash substitues.
The at-risk stub represents three embedded options:
(1) NRG equity
(2) litigation and tax recoveries against Edison International (EIX)
(3) potential overbid proceeds
EME is being acquired by NRG Energy (NRG) under a consensual plan
EME has the following non-risk assets:
(1) $1,063mm of cash at EME (see press release)
(2) $1,222mm of implied cash contribution from NRG ($2,635mm purchase price less $1,063mm cash at EME less $350mm of stated NRG equity value equals $1,222mm of cash)
(3) ~$209 of cash build beyond the $1,063mm of cash from (1) above (educated guess based on run-rate from EME's monthly operating reports)
Total = $2,494mm
EME has admin and priority claims of:
(1) $72mm of professional fees & expenses (estimate from Houlihan)
(2) ~$52mm of pension liabilities agreed upon with EIX (previously agreed upon; final number to be negotiated again; max liability ~$200mm)
(3) $211.7mm of cure amount for secured lease notes at EME's Midwest Gen subsidiary
Total = $336mm
EME has unsecured claims of:
(1) $100mm GUC claims (educated guess)
(2) $3,854mm of senior unsecured notes (your claim)
Total = $3,954mm
That puts the non-risk recovery at:
$2,494mm
(-) $336mm
= $2,158mm
(/) $3,954mm
= 55% recovery
You are paying 75 points, so your net stub claim is 20 points.
Now let's review the three embedded options behind your stub claim.
First is the NRG equity. NRG is contributing $350mm of stated equity value to EME, but it is really a fixed amount of NRG shares (12.66mm shares) with exposure to NRG's share price. NRG is currently $26.60/share but has recently been $30/share, so this is worth $337-380mm.
Next is the litigation/tax recoveries from EIX. Under the plan, the litigation recoveries are being retained by EME (i.e., not purchased by NRG) for your benefit. EME/EIX operate under a tax-sharing agreement. EME/EIX had initially signed an transaction support agreement (TSA) with EME noteholders for its Dec 2012 bankruptcy filing to effectuate a delayed debt-for-euity swap in late 2014 in order to allow EME to benefit from projected tax-sharing payments. The delay was required because EIX must legally retain 80% of EME's equity to consolidate EME on its tax returns. Federal tax law allows the profitable EIX company (via its Southern California Edison (SCE) utility) to offset taxable income by making payments to the unprofitable EME company, but only as long as EIX retained 80% of the equity in EIX. Well EIX/SCE had not been recognizing taxable income because of bonus depreciation rules. That was slated to expire completely in 2013, and the EME noteholders signed their agreement with EME/EIX under assumption that EIX/SCE would have taxable income in 2013/2014. Well, congress mucked that up with the American Taxpayer Relieft Act of 2012--part of the fiscal cliff deal--which extended bonus depreciation. The assumed recovery to EME noteholders changed, which created an IRR problem. By July 2013, the consenting EME noteholders terminated the TSA. By the next week, the creditors' committee filed a motion to prosecute EME's claims against EIX for "fraudulent conveyance, illegal dividend, preferential transfer, fraud, negligent misrepresentation, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, unjust enrichment, alterego liability, substantive consolidation, equitable subordination, disallowance of claims, and declaratory judgment." EME noteholders are now trying to hire the ex-TXU CEO as an advisor on these claims. The potential damages include:
(1) $702mm tax-sharing payments expected from EIX to EME under original TSA
(2) $183mm tax-sharing payment from EME to EIX in Sep 2012 (default on EME senior unsecured notes occured in Nov 2012)
(3) $26mm fraudulent transfer/unlawful dividend from EME to intermediate parent in Jan 2007
(4) $899mm fraudulent transfer/unlawful dividend from EME to intermediate parent in May 2007
(5) >$1,000mm breach of fiduciary duty by EME directors who were officers of EIX/SCE
(6) $TBD overpayment for shared services provided by EIX/SCE
(7) $TBD alter ego liability against EIX
(8) $TBD disallowance of claims from EIX
Total >$2,810mm
Last is the potential for overbid proceeds. This is the most speculative option. EME has a go-shop until 12/6/13. EME's banker said 29 parties submitted indicative bids and that initial indications were for all as well as portions of EME.
By paying 20 points for the stub claim, you are paying $770mm for the entire class of senior unsecured notes ($3,854mm * 20% = $770mm). Add in the $100mm in GUC claims, and you are paying an implied recovery of $870mm for these embedded options. If you agree the the NRG equity is worth $337-380mm, so you are paying $490-533mm for the litigation/tax and overbid options. This just seems cheap when reviewing the list above. Just the tax-sharing payments expected under the original TSA alone would give you 32-43% upside on the stub claim ($702mm on $507-557mm). Add in something like another $400mm for litigation settlement and/or an overbid, and you are talking about a double on your money. Given where the prior TSA was, I see a downside that isn't a donut and several ways to more than double your money.
I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.
Catalyst
Inherent nature of the bankruptcy process